Deregulation deja vu


California deregulated its electricity industry in 1998, and shortly afterward the lights went out. Apparently, regulators hadn’t realized how easy it would be for unscrupulous traders such as Enron to manipulate the state’s power market once it was open to competition; the results were rolling blackouts and skyrocketing electricity charges. Californians are still paying the price for all this -- in many areas, power bills are inflated with extra fees to cover bonds and other expenses incurred during the disastrous experiment.

We bring up this painful history because the state is about to embark on a new program that will radically impact utility regulation. This time, it’s being driven by an environmental imperative: With the effects of global warming becoming more apparent daily, the state has committed to cut its greenhouse gases 25% by 2020, and electricity generation is the state’s second-biggest source of greenhouse emissions after the transportation sector. To spur the needed changes, regulators are designing a cap-and-trade program, in which carbon emissions are capped and power generators can trade carbon credits -- permits to pollute -- among themselves. This is a staggeringly complex undertaking that will once again create opportunities for dishonest traders to manipulate the market.

In other words, unless the cap-and-trade program is designed extraordinarily well, we could be looking at deregulation deja vu. And the consequences won’t just be higher power bills. If California, which leads the country in addressing the threat of global warming, gets this program wrong, it could discredit efforts to fight the problem nationwide, if not worldwide.


This page has addressed the many dangers inherent in cap-and-trade programs (see the “A Warming World” series at To sum up: Carbon-trading markets are easy to manipulate and produce volatile energy prices, and the political influence of business and other lobbies can skew the system to produce unfair outcomes. On top of all that, California faces a special complication that would make its program the riskiest ever undertaken.

Cap and trade has proved a winning strategy in the U.S. for reducing emissions that cause acid rain. It’s also being tried in Europe for carbon emissions, though its progress there so far has been rocky. All existing cap-and-trade programs have one thing in common: They regulate the source of the emissions. The power plant or refinery or factory churning out the carbon is responsible for controlling its own emissions and trading credits. That won’t work in California, because from 22% to 32% of our power is generated out of state, and California can’t regulate plants outside its borders. Moreover, those out-of-state plants tend to be much dirtier than local ones. So how does a statewide cap-and-trade program account for all that pollution?

The solution proposed by the California Public Utilities Commission, which is developing the outlines of the program (the final decisions will be made by the state Air Resources Board, but the PUC’s recommendations will carry a lot of weight), is to regulate the “first deliverer” of electricity. This is whatever entity sells power to the California grid.

A lot of this outside power comes not from individual plants but middlemen who buy power from plants all over the Western U.S. and sell it to investor-owned utilities in California. It’s very hard to track where these power wholesalers are getting their juice. That presents an invitation for power dealers to game the system by pretending they’re selling clean power when it’s really dirty. It’s also questionable whether the program would reduce emissions. If power wholesalers are the ones responsible for buying carbon credits, there’s little incentive for dirty plants outside California to clean up their act.

Carbon taxes are a simpler, harder to manipulate and less economically damaging way to make polluters pay the costs of their environmental damage than cap and trade. Yet because taxes have so little political support, California regulators are charging ahead with a far riskier strategy, which has never been tested. Cap and trade stands a decent chance of working at the national level, where individual power plants could be regulated regardless of which state they’re in, but California will be asking for trouble if it imposes a statewide program.

The PUC is expected to finalize its recommendations in August, after which they’ll be considered by the air board. If it goes ahead with cap and trade, you might get a shock from your power bill. And be sure to keep plenty of candles on hand.